The best books on the impact of psychology on economics and finance

Who am I?

I became a behavioral economist in the 1970s, at the time modern behavioral economics came into existence. Much of my work has focused on the way in which the combination of emotions and deliberative thinking impact the way people make decisions about their economic lives. For over four decades, I have been identifying the fascinating ways in which this two system psychological approach influences the important questions of our day.

I wrote...

Ending the Management Illusion: How to Drive Business Results Using the Principles of Behavioral Finance

By Hersh Shefrin,

Book cover of Ending the Management Illusion: How to Drive Business Results Using the Principles of Behavioral Finance

What is my book about?

Psychologically smart companies manage both the pluses and minuses of human psychology through well-structured systems and processes. In Ending the Management Illusion, behavioral finance pioneer Hersh Shefrin addresses the biases that can take you or your organization off course and shows how to run psychologically smart businesses-specifically as it affects your bottom line.

Shefrin explores the psychological barriers you experience, and delivers concrete nudge-based debiasing techniques for breaking through these barriers. This allows you to integrate your processes for accounting, planning, incentives, and information sharing-the main elements for optimizing corporate value. The proof of the pudding is in the eating. The companies his book discusses which chose to employ these techniques performed favorably in the period following publication, while the companies that chose not to employ these techniques performed poorly, and in some cases disastrously.

The books I picked & why

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Thinking, Fast and Slow

By Daniel Kahneman,

Book cover of Thinking, Fast and Slow

Why this book?

To my mind, this book is tops in providing a general exposition of the two-system psychological approach to analyzing human judgments and decisions. For over half a century the book’s author, psychologist Daniel Kahneman, has been has been a major contributor to the modern psychological approach that underlies behavioral economics. In 2002, Kahneman was awarded the Nobel Prize in economics for his contributions. I feel fortunate to have known him since the 1970s and to have learned so much from him and his late co-author Amos Tversky.

Nudge: Improving Decisions about Health, Wealth, and Happiness

By Richard H. Thaler, Cass R. Sunstein,

Book cover of Nudge: Improving Decisions about Health, Wealth, and Happiness

Why this book?

Nudge is a seminal work about using psychological insights to help people make better economic decisions for themselves. The principles which authors Richard Thaler and Cass Sunstein articulate in the book are being applied globally in what have come to be called “behavioral insight teams” or “nudge units.” I would call this book a “game changer,” because prior to its publication there was a general view that people are too set in their psychological ways to change their behavior, even when doing so would be to their benefit. The germ of the main ideas in Nudge trace back to work which Nobel laureate Thaler did earlier in his career. Much of this work was with coauthors, of which I was one, which makes me especially appreciative of how remarkable the book is.

Irrational Exuberance

By Robert J. Shiller,

Book cover of Irrational Exuberance

Why this book?

The term “irrational exuberance” which forms the title of this book, entered the public lexicon in 1996, days after the book’s author, Nobel laureate Robert Shiller, gave a presentation about stock market bubbles to the Federal Reserve. Alan Greenspan, who was Fed chair at the time, used the term in a public speech; and the rest is history. The book Irrational Exuberance provides an account of how psychological forces generate asset pricing bubbles. The book was published during the dotcom bubble, and proved to be prophetic in the way it anticipated the subsequent housing pricing bubble which preceded the global financial crisis and associated great recession. Readers will find amazing insights in this book, especially about the way that history repeats itself when it comes to asset pricing bubbles.

The General Theory of Employment, Interest and Money: With the Economic Consequences of the Peace

By John Maynard Keynes,

Book cover of The General Theory of Employment, Interest and Money: With the Economic Consequences of the Peace

Why this book?

Keynes’ book is not just a classic, but to my mind is the finest book in economics written in the first half of the twentieth century. Although I studied the book as an undergraduate student, at the time I failed to appreciate what Keynes wrote about the role psychology played in economic decision making. It was only after becoming a behavioral economist myself, and re-reading the book, did I realize that Keynes was a stellar behavioral economist. Although many professionals learn about Keynes’s ideas from other sources, there is nothing like the original. In this work Keynes speaks to us about how human psychology impacts economic decisions and events. Those who read carefully will see that he writes about psychology, optimism, confidence, and sentiment – terms very much in vogue today among modern behavioral economists.

Stabilizing an Unstable Economy

By Hyman P. Minsky,

Book cover of Stabilizing an Unstable Economy

Why this book?

Hyman Minsky might well have been the most underrated economist during the second half of the twentieth century. In Stabilizing an Unstable Economy, Minsky identified the psychological factors that create in financial markets and exacerbate economic downturns. Viewed against the backdrop of recent financial crises, his writings appear prescient. Readers of this book will discover that Minsky explained that the same factors which underlie economic instability also underlie the creative spark that produces economic progress. Readers will also learn that Minsky warned about being naïve in thinking that we can avoid instability.

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